The Poverty Of The Information Revolution
“It’s a good thing they brought Michael Murphy along,” wrote Dan Denning from San Francisco yesterday. Dan was attending a financial conference, and articulating the point we have (unintentially) demonstrated time and time again: you can’t predict the future.
Murphy thinks “he CAN predict the future,” Dan reports, “And he says we’re in the middle of what he calls a ‘Transcession’.” Evidently, the economists’ glossary was insufficient for Mr. Murphy, who needed a new word – a mot juste – to describe this new phenomenon.
What is it, you may wonder? Dan explains: “It’s the period when a revolution displaces the incumbent economy. For example, the Industrial Revolution began in roughly 1845, but didn’t seriously disrupt the Agrarian economy until 1870’s when the new technologies went from being disruptive to commonplace. Mass production hit full stride in 1918…[Remember, this is all according to Michael Murphy, who – I will warn you – thinks he sees another ‘Revolution’ in the making] but it wasn’t until the 1930’s that the division of labor was fundamentally altered by the machine.”
“And as you might guess,” continues Dan’s report, “IBM introduced the PC in 1981. And this, according to Murphy, will start destroying the Old Economy in earnest by 2003.”
Racing ahead, and to fully disclose our bias, I will also warn you that 4 of Murphy’s ‘must own’ stocks for the new revolutionary economy are the very same ones which Dan and Lynn Carpenter have identified as ‘must sell’ stocks for the readers of their Fleet Street Letter: AOL, Cisco, Intel and Oracle.
Transcession must be the fall-back position for the New Tech bulls. The Nasdaq is down 46% from its March high – and some of the ‘must own’ tech stocks are down even more. Computer sales, chip sales, telecoms, Internet sales, profits, growth rates, GDP growth – just about everything associated with the big techs seems to be disappointing. “People are realizing,” said a ‘global strategist’ for Merrill Lynch on the front page of the International Herald Tribune today, “that tech stocks are cyclical.”
But now the dreamers and schemers among the New Era believers have figured out an explanation: there is a time lag between the introduction of ‘disruptive technology’ and its radical consequences.
In fact, a Daily Reckoning reader wrote yesterday to pose the question: “Isn’t it possible,” he asked…making it hard to deny… “that information alone may not make people rich…but when it is applied by businesses to make better, faster, cheaper products it will then pay off in an astonishing way?”
Yes, it is possible. More access to information at lower cost should allow more people to do more different things, more efficiently. Everyone will benefit. Production will be improved. Prices will fall. We will all be richer.
But save the astonishment. You may need it when you see how low the information mongers – AOL, Cisco, Intel, IBM, AMZN – go.
I return, today, as I threatened to do, to the subject of American capitalism…and why you cannot now buy shares in many of the leading public companies and expect to profit. More than that, I want to show you how the promise of the Information Revolution is making businesses and investors in America poorer, not richer.
You may recall how America’s credit bubble made consumers poorer. Not wanting to miss out on the fast, easy wealth in the stock market, Americans became momentum investors at a time when momentum had reached record levels. Watching their portfolio statements go up month after month, people felt richer. And offered new credit every time they went to their mailboxes…they found that they could improve their standards of living, beyond the increases in their earnings, while still getting richer.
So, they borrowed and spent…and bought more stock. They borrowed at 8% or more to buy TVs, vacations, and “I’m with stupid” tee-shirts that yielded no financial return. And the stocks they bought, similarly, yielded no more than a Paris taxi driver in a traffic circle.
For a long time, though, Mr. Market told them they were getting richer. But Mr. Market has a way of changing his mind. Already nearly $3 trillion of ‘wealth effect’ has disappeared. And the debts remain. At some point, depending on when and how much stock they bought – investors become net losers. Having spent more than they could afford to spend, they are actually poorer then when they began.
This is true of the entire economy. During the last five years, spending increased faster than income. Putting aside the unrealized gains on stocks (which are fast disappearing) the whole society is poorer…it has been hollowed out by the mass delusion of the Information Revolution.
But what is true of consumer households is also true of business. They borrowed at high yields, and bought assets with low ones…sometimes they bought other businesses, as Cisco did, or their own stock, as IBM did. “From a strict economic perspective,” comments Dr. Kurt Richebacher, Austrian-school economist and old-school moralist, “it is hard to imagine a greater economic folly…”
Why would corporations do such a thing?
“In a world where managers’ incomes are effectively linked to what is currently happening to stock prices,” answers Dr. Richebacher, “there is a very strong incentive to put the instant maximization of shareholder value over any other consideration, regardless of foreseeable, adverse micro- and macro- economic consequences in the longer run. It’s the policy of the desperado who has everything to gain in the short run and nothing to lose in the long run.”
As reported here previously, IBM increased it revenues only 5% over the last 4 years…and profits only 1.3%.
“However,” Dr. Richebacher continues, “thanks to a massive $34 billion share buyback program, it managed an average annual rise of 10.5% in the one number that Wall Street treasures above all others: per share earnings. Meanwhile the debt ratio when skyward.”
The way to build wealth is no secret. You must save money and invest it in things that will produce more. A farmer saves his ‘seed corn’ and then plants it. The more he saves and the more he plants – the more corn he will have. Businesses need to take savings (either their own accumulated profits or the savings of others) and build new plants and equipment that will turn out more goods and services more efficiently.
Of course, most businessmen went about their work in the ordinary way during the ’90s boom. But many were infected by a group-think virus that was in tune with the illusion of the Information Age and investors’ desires to get rich quick from it. They called it the “shareholder value model”.
“The conspicuous peculiarity of the shareholder value model is its enthrallment with corporate restructuring,” explains Dr. Richebacher. “Basically, restructuring is a vague euphemism for all kinds of measures that tend to enhance shareholder value in the short run, virtually to the exclusion of any other goal.”
Richebacher refers to this as “late, degenerate capitalism” and characterizes it as “a frantic chase of corporate management after quick and easy profits in the stock market through deal making and stock buybacks…the responsibility of the corporate manager under this ‘new’ capitalism begins and ends with the near-term stock price.”
“It’s late, degenerate capitalism in the sense that saving and capital accumulation have fallen into complete oblivion,” Richebacher observes. “Worse still, it is a capitalism which any educated nation should be ashamed of… What really happens is rampant over-consumption at the expense of future generations who are to inherit depleted domestic capital formation, a mountain of foreign indebtedness and lots of worthless paper assets (stocks and bonds)…”
Richebacher describes how these companies make the whole economy worse off: “Rising stock prices add nothing to an economy’s capital stock. What they create is the exact opposite: soaring claims on the part of the stockowners on the national product and its capital stock. …The booming stock market of the late 1990s has furnished stockowners with virtually limitless actual and potential purchasing power, and as a rule, this happens to stimulate borrowing and spending… As fewer resources remain available for new investment, such a switch in the use of resources ranks in economics as “capital consumption”.
It is as if, to use a familiar expression, the farmers ate their seed corn.
Your long-winded correspondent,
Paris, France November 30, 2000
P.S. As the price of information falls…companies will put it to work. They will use it to inform their decisions…about what new factories to build and how to design them better. The auto companies will learn to produce and market better cars at lower prices, for example. This will not be the result of an Information Revolution, however, but of a haphazard evolutionary process of learning…by trial and error, luck, hard work and inspiration. The companies that will prosper will be those who figure out how to use the information available to them. Who knows, among them could even be one of Michael Murphy’s ‘must own’ stocks. No one can predict the future.
*** “It’s a very delicate market,” said an analyst yesterday, “one that moves quickly and mercilessly if there’s anything perceived as being negative.”
*** But what could be ‘negative?’ Yes, the economy is slowing…the revised figure for the last quarter showed a 2.4% growth rate – the lowest in 4 years. And after-tax profits growth rate dropped to 0.6% – the worst performance since the ’98 Asian currency crisis.
*** And, yes, an old friend reports that the IPO he scheduled for a start-up tech company had to be rescheduled for January. And the WSJ adds that IPO investors are losing interest in the new tech start-ups. “Everyone’s bearish” on technology said another source – quoted by Reuters.
*** And, yes, collapsing Nasdaq prices have already wiped out nearly $3 trillion in stock market wealth – an amount equal to almost the entire increase in wealth gained by all the households in America in 1998. And still the average stock is overvalued by 2, 3, maybe 4 times.
*** And it’s also true that the latest Presidential election was perhaps the most bollixed in American history.
*** And, yes, energy prices are twice what they were a year or so ago…and heating oil stocks are worryingly low. And the International Herald Tribune reports today that “Economic Signs Point to a Global Slowdown.”
*** But apart from that – what’s the problem?
*** The Nasdaq fell modestly yesterday, losing 28 points, and dropping to its lowest level since Oct. ’99. It has been down in 12 out of the last 15 session.
*** The Dow rallied, up 121 points. But there was no breadth behind the numbers… 1465 stocks advanced on the NYSE; 1396 declined. 101 issues hit new highs; 143 hit new lows.
*** The real action happened in after-hours trading. Altera and Gateway each fell about 25% after warnings of lower earnings in the 4th quarter. Intel lost 10% to close well below $40. Dell dropped below $20 to a fresh 2 « year low.
*** “Market wipeouts now take months instead of years,” says Ray Devoe. “The number of stocks down at least 95% from their 52-week highs is staggering. Some have fallen at least that much in 2-3 months. The latest casualty is Mortgage.com (MDCM – $0.03) that has fallen from $22 a share in August 1999 to 3 cents today – a loss of 99.9% in 14 months.”
*** When will the ‘dot.com dollar’ follow the dot.com stocks? Maybe we will not have to wait long. There is a “perception that the U.S. economy may be headed for trouble,” said a gnome in Zurich, quoted in the Financial Times, “the dollar is over-valued and people are realizing that and reducing their long dollar positions.”
*** The dollar fell again yesterday – to 86 cents/euro. Oil rose 41 cents. And gold fell $3.40.
*** “It’s only been 10 months since Janus closed some of its funds to new investors,” writes Eric Fry, “and already the firm cloisters itself in a shroud of secrecy. Still, sagging investment returns are hard to conceal. The flagship Janus 20 fund, after gaining a blistering 65% last year, is down more than 20%… and a whopping 30% from its March 24 high. Likewise, many of its other funds are suffering losses on the year.”
*** “This morning on Good Morning America,” reports a colleague from Baltimore, “a stock analyst showed Diane Sawyer two stocks, Cisco and Philip Morris and asked her which see would have thought fared better since Jan 1: Cisco, down 3% and Phillip Morris up 63%.” Near the beginning of the year, Daily Reckoning readers were advised, if I recall correctly, to sell Cisco and buy Phillip Morris. So far, so good.
*** “You are a blabbermouth,” (or words to that effect) scolds my old friend Harry Schultz, Chevalier, KOM, and BSD. “Only a friend would tell you,” he writes, suggesting that I cut back the Daily Reckoning dramatically. He’s probably right. But there’s so much going on…
*** A survey by the Consumers Federation found that people are getting worried about debt. 24% of those polled said they intended to cut back on holiday spending.
*** And here’s a man-bites-dog story: Crosspoint, a $1 billion Venture Capital tech fund in the S.F. Bay Area decided to rap up the fund and return the money. “Unless we can look them [investors] in the eye,” said the remarkably honest John Mumford, “and say we believe we have a great model to make all of this money, in good conscience, we can’t go forward.” Conscience, good or bad, didn’t prevent venture capital firms from raising $70 billion in the first 3 quarters of 2000, compared to only $11 billion in ’99.
*** And, according to one correspondent – a usually unreliable source – for all the blessings of its dynamic economy and New Era technology – the U.S. still is not among the top 7 countries in terms of per capita income. The Top countries are Japan (even after 10 years of recession and bear markets), and a collection of rigid European Social Democracies, including Denmark, Sweden, Germany, Luxembourg, Norway and Austria.